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Exelon - A Best Buy?

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By kelbon
December 11, 2009

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Exelon Corporation (EXC)

To follow up on a thread on utility stocks, for my money; on an individual basis, Exelon is potentially one of the best buys out there. That is, if you have some patience.

Exelon Corporation operates 17 nuclear power plants. There are several advantages to nuclear power over other methods of generating electricity. Number one: it's cheaper-once the plants are built and up and running. It's also much less polluting and, looking forward, to quote Value Line: "Exelon's nuclear plants will become even more valuable if climate change legislation is enacted that would increase the cost of coal-fired plants."

What establishes Exelon's dominance and moat in it's markets is that it's very expensive and time consuming to build nuclear power stations. But, once they're built they produce very good returns. Exelon's ROE has consistently been in the upper teens and lower twenties (%) since 2001. In comparison the average ROE for electric utilities is 11%.

In spite of the fact that it's very capital intensive to build a network of nuclear power plants, EXC, over the last ten years has spent around 50% of their free cash flow on capital expenses, compared say with a railroad company who spends a significantly larger portion in creating and sustaining their dominance.

It's unlikely that electricity consumption is going to drop much further than present levels and as the economy picks up manufacturers will inevitably use more electricity. Many consumers will, no doubt, become less vigilant about their own energy consumption as the economy improves. This, of course, applies to all electricity utility companies, but it's worth bearing in mind.

Historically, Exelon has sold at a premium to other electric utility companies, especially if you compare dividend yields. Until this year EXC's dividend yield never exceeded 4%. Also it's payout ratio has been modest on an industry comparison basis at usually just under 50%. Currently EXC's yield is 4.2%. (The lower the percentage of cash flow a company pays out in dividends, the more it has over to reinvest in its business).

Since 2001 Exelon's per share earnings growth, with a CAGR of 10.5%, has been on the high end compared with the industry. Many utilities earnings growth rates barely keep ahead of the inflation rate.

Exelon's stock price has taken a beating since summer '08 when it reached a high of $92. Now, at $50 a share, it trades at a forward p/e of 11.6, the low end of its historical range. Couple that with a dividend yield at the highest end of its range and there's no doubt that the stock is selling at a historical discount.

Exelon has underperformed most utilities lately and that's because of disappointing earnings guidance for 2010. (This is where the patience part comes in). What will probably amount to one disappointing year and perhaps no dividend increase for '10 seems to be providing a good entry point for investors. When Exelon is firing on all reactors it's been a very good investment in the past and there no reason to think it won't be again.

Value Line ranks. EXC 1 (highest) for Safety and A+ for Financial Strength, with Earnings Predictability at 95 (out of 100).
Morningstar reckons its "fair value" to be $76 a share.

Exelon is a company with strategic advantages selling a non-discretionary product which it is able to generate a good profit on, whose earnings have significant upside potential as, and when, demand increases.

On a risk/reward basis EXC seems to have little permanent down-side risk (excluding another Five Mile Island) and good upside potential. At these prices you're getting paid over 4% to wait, higher than the yield on 10-year treasuries.

As always, do your own due diligence :)